Effectuation – New Paradigm of Entrepreneurship

The business world is permeated through and through this kind of rationality, based on what we see is happening today in the world, what are the trends? what will be the consequences? are forecasted the solutions in a business environment.

However, according to Saras Sarasvathy, it is not how entrepreneurs think. The thought process is not “causal” but “effectual”. When a project is approached, the entrepreneur has three means skills: his own innate abilities, skills acquired through education and personal contacts. The entrepreneur is guided by a simple maxim: “To what extent can we control the future, we do not need to predict it.” Here lies all the difference. According to Sarasvathy, the successful entrepreneur does not try to predict what will be the most profitable markets, very opposite idea to Henry Mintzberg.

Effectuation - New Paradigm of Entrepreneurship

In 1997 Saras Sarasvathy, professor of business and ethics at the University of Virginia but then a student of the prestigious Carnegie Mellon University, decided to interview thirty founders of companies with market capitalization’s between $ 250 million and U.S. $ 6,500 000,000, in an attempt to determine empirically what the real characteristics of entrepreneurs is. The image that came off the analysis of the interviews was surprising, the process of creating business plans seemed sorted out and more or less anticipated results. Instead, they could feel more adaptive and transformative tactics, in which first evaluate the type of resources that are available and then the possible ideas. This reversal of the situation is what the name of this new form of business development explained: “effectuation” or effect ahead of the cause.

“A meek mission like cooking a banquet can be used to contrast the causal thinking effectual thinking,” says Sarasvathy. “A chef who is given a specific menu and simply told to select the favorite recipe, and buy the elements and cook dinner in your own well equipped kitchen, is an example of causal reasoning. An example of effectual reasoning would be a chef who does not know the menu in advance, is escorted to a strange kitchen where you have to explore the cupboards with unknown ingredients and cook dinner using his own ideas.”

Both arguments were made by people with skills defined (in this case a chef) and knowledge that allow you to perform a task effectively, but in the case of the second chef there is also a requirement of imagination, spontaneity and the ability to take risks.

Effectuation Principles

The process of entrepreneurs who follow effectual reasoning starts by asking what skills they already have and assess what knowledge or opportunities exist within his inner circle. From that base, begins a search for ideas that could be implemented within that environment. Sarasvathy also notes the existence of patterns of behavior that emerges from the study of his interviews, and groups on five principles:

  1. Bird in the hand Principle: the entrepreneurs should start with their own opportunities and not wait for the perfect opportunity appears. Taking action based on what you have is better than delaying any release until all conditions are defined in a plan.
  2. Affordable loss Principle: instead of elaborate calculations of risk and return on investment, entrepreneurs must evaluate how much you are willing to lose if the bet does not go well.
  3. Lemonade Principle: lemonade can be transformed into sweet lemonade, the entrepreneur can take advantage of the contingencies and turn them into an opportunity. Shall surprises arising from uncertainty, and remain flexible rather than tied to existing targets.
  4. The crazy-quilt Principle: partner with individuals and organizations willing to take a real commitment to jointly create a future product, service, or market. Do not bother with the study of competition or strategic planning.
  5. The pilot on the plane: focus on activities that are within the scope of the entrepreneur, the more likely that the results are close to expectation. The idea is not to try to predict the future, but to create it.

Entrepreneurs using Effectuation

Effectual reasoning examples flourish in the history of building successful companies. Richard Branson, founder of Virgin conglomerate, began selling music through his school magazine until he saw the opportunity to create record store and later (helped by a family loan) his own music label. His latest commercial venture is the creation of the first airline space flight. There is also the famous Tiffany’s New York store began as a bookstore and gradually became a jeweler, perhaps one of the most recognized in the world. But the most cited example is the U.S. company U-Haul, a network of rental moving vans that extends throughout the Americas, founded in 1945 by Leonard and partner Anna Shoen. At the time they were married, Leonard and Anna spent many years moving from one friend’s house to another. Once married, the couple decided to start some activity and managed to raise about $ 5,000 from family members to use as capital. Shoen was bought and the vans created his first U-Haul. The $ 5,000 will be finished soon, but Shoen had a brilliant idea: to sell the vans to his friends and family, who then granted the company rent. In one stroke the Shoen extended their capital, their partners and their network of customers, while collecting possible losses of the company. To expand its sales network the Shoen had another brilliant idea: to partner with the owners of gas stations across the country, which provided him with parking space fleet while they became partners. In ten years U-Haul created a fleet of 10,000 rental vans.

Effectuation vs. Causation

The reasoning is analytical or causal if selecting the right resources to achieve its objectives. This way of thinking starts with a goal and a given set of resources, and in that situation trying to identify the best alternative (faster, cheaper, more efficient, etc.) to reach its target.

Meanwhile, effectual reasoning or creative is to imagine possible alternative endings that can be achieved using a given set of resources. In this case, the starting point is not a specific objective but a set of resources that allows the objectives defined contingently over time based on the aspirations of the entrepreneur and the network of relationships around them.

Under this reasoning, the entrepreneur, according to their characteristics (tastes, skills,etc.), knowledge (education, training, experience, etc.) And the set of people related (network of social and professional contacts), is able to take the initiative to take a chance.

In balancing both types of reasoning is found that causal reasoning focuses on the return or the expected reward, while effectual reasoning stresses assumable losses. It also uses the causal thought for competitive analysis, while thinking about strategic alliances. Similarly, causal reasoning use prediction to exploits existing knowledge, while effectual thinking emphasizes the use of contingencies.

As it can be seen, the logic behind each of these ways of thinking is radically different. While causal reasoning assumes that “as long as you can predict the future, we can control it,” effectual reasoning considers that “to the extent that it can control the future, it is not necessary to predict it.”

References:

  • Sarasvathy 1997, SARAS D. SARASVATHY (2001) ‘Causation and Effectuation; Toward a Theoretical Shift from Inetitability to Entrepreneurial Contingency’, Universty of Washington.

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